Inheritance tax (IHT) is probably the last tax on the minds of most business owners. This is probably because they are more likely to be concerned with corporation tax, income tax, National Insurance, VAT. However, should they be concerned about IHT? It would seem that some business owners may have a vague recollection that IHT doesn’t apply to shares in a trading company. They are exempt from IHT provided the relevant conditions are satisfied. 100% business relief (BR) (previously referred to as business property relief) is indeed available for shares in an unquoted trading company which have been owned by the transferor for at least two years. On the face of it this seems simple enough although a little more thought needs to be given to those conditions before consigning a business interest to the “no IHT due” box.
In this article we consider the basic conditions which need to be satisfied for business relief to apply and how excess cash held in a business could affect the position.
IHT BR is available for transfers, during lifetime or on death, of certain categories of business and business property. Where the relief applies the value attributable to what is called ‘relevant business property’ is reduced by 50% or 100% depending on the category into which it falls. For example, a holding of unquoted shares would qualify for relief at 100% whereas land, buildings, plant or machinery owned by a partner, and used wholly or mainly in the business of the partnership, would only attract relief at 50%.
Relevant business property
BR is available on transfers of the following categories of ‘relevant business property' at the rates shown below.
At 100% for:
- A sole proprietor's business or an interest in a business (such as that of a partner).
- A life tenant's business or interest in a business (including assets of which he or she was life tenant in possession under a settlement which were used in that business).
- A holding of unquoted securities which by themselves or in conjunction with other such securities owned by the transferor and any unquoted shares owned by him gives him control of a company.
- Unquoted shares.
At 50% for:
- Shares or securities of a company which are quoted and which either by themselves or in conjunction with other such shares or securities owned by the transferor gives the transferor control of the company.
- Land, buildings, plant or machinery owned by a partner or controlling shareholder and used wholly or mainly in the business of the partnership or company immediately before the transfer, provided that the partnership interest or shareholding would itself, if it were transferred, qualify for business relief.
- Any land, buildings, machinery or plant which, immediately before the transfer, was used wholly or mainly for the purposes of a business carried on by the transferor, was settled property in which he or she was then beneficially entitled to an interest in possession and was transferred while the business itself was being retained.
Relief is not available where the business or company is engaged wholly or mainly in dealing in securities, stocks or shares, land or buildings or in making or holding investments unless:
- The business is that of a market maker or discount house in the United Kingdom
- The company is a holding company and the group as a whole is not wholly or mainly engaged in property, investment or dealing.
Whether or not a business is regarded as wholly or mainly an investment business has been the subject of many cases and more recently the subject of a series of cases relating to caravan parks. In Weston v IRC  STC 1064, the Commissioners outlined the factors that are to be taken into account, as cited in their previous decision in Farmer v IRC SpC 216 as follows:
‘…the overall context of the business; the capital employed; the time spent by the employees; the turnover; and the profit. When these factors have been considered it will then be necessary to stand back and consider in the round whether the business consisted mainly of making or holding investments.’
Therefore it is not as simple as looking at one aspect of the business to come to a conclusion. Basically, the business has to be looked at as a whole to determine whether or not BP will apply.
Minimum period of ownership
Property is not relevant business property unless it was owned by the donor throughout the two years immediately preceding the transfer. Where a charge or increased charge to IHT arises because the donor dies within seven years of a transfer of relevant business property, business relief is available only to the extent that the donee still owns the original property received on the transfer, and provided that the property remains property qualifying for business relief. These basic rules are extended to cover replacement property.
Where the donor acquired the property on a person’s death, he or she is assumed for this purpose to have owned the property since the death (the fact that he or she does not own it until the personal representatives distribute it is ignored). Where the donor acquired the property on the death of a spouse or civil partner, he or she is treated as having owned it since the spouse or civil partner acquired it.
The value of relevant business property for the purposes of the relief is worked out in the normal way. The amount of any relevant business property which qualifies for the relief is reduced insofar as it is attributable to excepted assets. An asset is excepted if it was not either used wholly or mainly for the purposes of the business throughout the two years immediately before the transfer (or since its acquisition by the business if more recent) or required at the time of the transfer for future use for the purpose of the business. An asset is also excepted if it was used wholly or mainly for the personal benefit of the donor or a person connected with the donor.
Cash held in a business
So, what effect can excess cash in a business have on BR for inheritance tax? At worst, it can affect the “trading” status of the business which can in turn totally deny 100% BR and, assuming that this dramatic complete denial is avoided, it can also affect the proportion of the value of a shareholding in a company that qualifies for BPR.
Under the excepted assets test BR is reduced to the extent that the value of the shares reflects any excepted assets held by the business. Broadly speaking, this anti-avoidance provision seeks to prevent “taxable” personal assets being “sheltered” from IHT by being held within a BR - eligible company. Such personal assets might include holiday villas and other “private” assets that are held within the company for the owner-manager’s private use. The excepted assets restriction can also prevent BR being given on “excess” cash reserves being built up within a business.
As stated earlier, an asset is treated as an excepted asset if it was not used wholly or mainly for business purposes in the previous two years, unless it is required for future use in the business. It seems that in order to determine this HMRC will generally seek to examine the accounts and other relevant business documentation at the time of a relevant chargeable transfer/death.
HMRC will often look at substantial cash balances to determine whether they are really required for future business use. There will, of course, be seasonal trades that generate a large cash balance at particular times of the year. In such cases, it should be possible to show that the cash was required to meet significant expenditure on re-stocking etc, after the date of death.
In difficult times some businesses may have decided to retain chunky cash balances to act as a buffer just in case things take a turn for the worse in the future. Many would argue that these amounts should be considered as being legitimately held for business purposes. However, somewhat surprisingly, HMRC has confirmed that, unless there is evidence showing that the cash is being held for a specific identifiable future purpose, it is likely to be treated as an excepted asset for BR purposes. HMRC has stated that holding a “surplus” cash buffer to ‘weather economic difficulties is not sufficient reason’ to prevent the funds being treated as an excepted asset (see ICAEW Tax Guide 01/14 issued on 16 January 2014).
Given the potential importance of this point it is highly advisable to retain evidence of directors’ decisions etc, as they will be crucial in rebutting any HMRC challenge in this area.
Cash held without an identifiable business purpose attached to it is likely to represent an excepted asset and excepted assets result in a proportionate denial of BR. If cash is held inside a business, for example, any cash held with an unidentified business purpose could result in a proportion of the share value failing to qualify for BR. So, if, say, 20% of the company’s assets (including goodwill) was represented by cash with no identifiable business purpose then only 80% of the share value would qualify for BR.
As indicated above, the “trading” test is determined on an “all or nothing” basis – the shareholding either qualifies in full (subject to the “excepted assets exclusion” – very relevant in relation to cash) or it does not. It is therefore possible for a company’s shares to fully qualify for 100% BR provided it is not mainly carrying out an investment business, ie it is mainly trading. Thus, a small or incidental investment activity run alongside a predominantly trading one would effectively attract BR through the value of the shareholding.